Setting the stage for more homegrown search funds

If calls from Canadians studying for their MBA qualification at U.S. universities to Steve Divitkos, the founder and managing principal at RedLeaf Partners Management are any indication, then the ranks of search funds that may be established in Canada are set to grow.

“It seems that a number of them are interested judging from the number of calls I have received,” said Divitkos. “There is obviously a level of interest in this investment vehicle among Canadians, which I think is great. In my experience the extent to which we all help each other is far greater than the extent to which we compete with each other,” said Divitkos, noting that search funds are a suitable investment platform for those “who are interested in the pursuit of entrepreneurship through acquisition.”

“A good way to think about a search fund is essentially as a succession plan looking for the right business to succeed.”

Indeed the MBA students are attempting to follow the path set by Divitkos who, after working in Infrastructure Private Equity and Private Debt groups at the Canada Pension Plan Investment Board, went back to university. After completing his MBA from Harvard he returned to Canada in 2012 and set up his search fund. He has raised the first round of finance from a group of 17 investors — the cash is needed to pay the overhead and operating costs of the search fund — and is now seeking a potential investment.

But unlike a normal private equity fund, RedLeaf Management Partners, along with the others in the search fund sector, will operate the small-medium sized business that his investment group acquires. As it states on its website: “Upon completing an acquisition, we will take an active management role in the day-to-day operations of the business and install a Board of Directors composed of some of the most experienced entrepreneurs, operators and investors in North America.”

It’s a similar story of a flurry of activity involving requests for meetings at what is believed to be the country’s oldest established search fund, OPK Capital. That firm, set up by Brian Astl and Sean Van Doorselaer, both MBA graduates, who met while both working for the Monitor Group, completed a major transaction in late 2007 when it purchased Lind Equipment. And the two aren’t thinking of implementing an exit strategy as they say they are enjoying the satisfaction that comes from running their own business and of being responsible for implementing what in the past would have been recommendations. In short the buck stops with them: they have to grow the business and to ensure for their investors, that they “provide above average long-term return on capital.”

But they are not SPACs

Search funds differ from the approach taken by a traditional private equity firm where day-to-day-management isn’t normally involved. They also differ from SPACs — or special purpose acquisition companies. In late 2008 the TSX adopted new rules governing the listing of SPACs. At the time much was expected from SPACs, which lawyers from Blakes termed as “a publicly traded shell company or blank-cheque company.”

“The SPAC structure should give seasoned mining industry participants with successful track records an excellent opportunity to establish a clean, publicly listed ‘war chest’ that can be used to make attractive acquisitions, as well as the opportunity to provide investors with a lower risk investment avenue to back these participants,” said a report from Blakes at the time.

SPACs differ from search funds in a few key ways: they try to raise a considerable amount of capital (at least $30-million was required); they try and use those proceeds to make a large acquisition; they are publicly listed and when an acquisition is made a vote from the shareholders is required.

It’s not known how many, if any SPACs were formed in Canada though at least two Canadian sponsored SPACs were formed. In 2005, Terra Nova Acquisition Corp. — a special-purpose acquisition company raised US$33.1-million. In 2006 TerraNova merged with ClearPoint Business Resources Inc., and became listed on Nasdaq. In 2007, Tailwind Financial Inc., another Canadian headquartered SPAC, priced a US$100-million offering. In 2008 it announced a deal with New York-based Asset Alliance Corp., an investment-management firm specializing in alternative investments. Its understood that the deal didn’t proceed. In April 2009, Tailwind Financial was liquidated with shareholders receiving about $8.18 a share — a small profit given that they had invested US$8 a share in the initial offering.